Telecom carriers: the Next Generation 10-6-98

} Telecom carriers: the next generation By Jeffry Bartash, CBS MarketWatch Last Update:

WASHINGTON (CBS.MW) -- Investors looking for a younger, more energetic telecommunications company than AT&T or Sprint have plenty of choices these days.

Several companies hold out plans to build networks of the future -- ones that can move data, video, sound, even whole computer applications, just as quickly as traditional phone carriers transmit voice today. And at far cheaper prices, to boot. But while they exhibit grand visions of the future, most have little to show, for now, in the way of profits and revenues.

Both are run by brainy executives who've spent time in the higher reaches of the companies they're now trying to topple -- Qwest boss Joe Nacchio at AT&T, Level 3 chief Jim Crowe at WorldCom. Both have strong financial backing and the nearly universal adulation of Wall Street. And both are rolling out nationwide digital networks based on Internet Protocol packet switching, a far superior method of sending information than the old circuit-based technology used by established long-distance providers.

"Basically, companies like Qwest and Level 3 are valued as much on their idea as on their infrastructure," said Boyd Peterson, a telecom analyst at the Yankee Group, a research firm in Boston.

Qwest for the best

Denver-based Qwest is probably in the best position at the moment, though analysts caution that the industry is young (barely more than a year old) and subject to lightning-fast change.

Although it only had $697 million in revenue in 1997, Qwest earlier this year managed to pull off the acquisition of LCI International, with $4.4 billion in annual sales, to become the nation's fourth-largest long-distance provider. To help finance construction of its 16,000-mile network, Qwest sold rights to surplus capacity to GTE (GTE)
GTE, +1.88%
, Frontier (FRO)
FRO, -3.50%
and MCI WorldCom (WCOM)
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for more than $1 billion. A few months ago, the company struck a deal under which US West (USW)
usw
and Ameritech (AIT)
AIT, +4.70%
were to market Qwest's long-distance services to their local-service customers.

Though the courts recently struck down that arrangement as a violation of federal rules banning Baby Bells from providing long-distance service, it certainly is exhibit A of the gusto with which Qwest is challenging the big boys.

Qwest shares fell 13/16 to 31 3/16 Tuesday.

Level 3 has not been as aggressive in marketing its products, but it's also a strong contender. Founded by James Crowe, a former board member of Qwest (don't invite him and Joe Nacchio to the same party), the Omaha, Neb.-based company is planning to erect a 23,000-mile network extending to three continents.

Like Qwest, Level 3 has sought out innovative means of funding, getting telecom visionary Craig McCaw and two of his offspring, Nextel (NXTL)
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and NextLink (NXLK)
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, to fork over $700 million for 25 percent of the capacity on Level 3's long distance U.S. lines. The company also raised $2 billion through a junk-bond offering in June, at the time the largest such issue ever.

Perhaps just as important, Level 3 in April acquired XCom Technologies, an obscure but important company that developed a method of making packet-switched phone calls connect just as quickly as traditional circuit-based ones. That gives it an edge over Qwest, which uses a clunkier process that results in slower connections.

While it builds its network, Level 3 has struck a deal to lease space on Frontier fiber lines.

Level 3 had $332 million in revenue in 1997.

Oligarchs vs. opportunists

Aside from Qwest and Level 3, other next-generation carriers commanding attention include NextLink, IXC (IIXC)
iixc
, Williams Networks and Frontier. NextLink is focusing on local service to businesses; IXC and privately owned Williams are concentrating on the wholesale market.

While it seems as if these companies are all in competition for a piece of a finite market for telecom services, that's not necessarily the case. Most have arrangements with each other to lease capacity -- what analysts call "co-opetition" -- and top executives are adamant that the demand for new bandwidth will soar and new uses for it will arise.

The bigger battle, analyst David Cooperstein of Forrester Research has predicted, will be between the "oligarchs" (AT&T, MCI WorldCom and the Baby Bells) and the "opportunists" (such as Qwest, Level 3, NextLink).

The reigning telecom giants aren't going to sit on their behinds while the young upstarts grow, but the AT&Ts of the world have stockholders to please and earnings targets to meet, and they're trapped by a reliance on old, circuit-based technology, on which they have lavished billions of dollars. It'll take longer for them to build new packet-switching networks.

The opportunists, meanwhile, are fast at work building their high-tech networks. That would drive down prices, potentially allow them to steal the most lucrative business customers from the oligarchs, and undercut their revenue streams even as the giants shift to doing battle with the upstarts.

Even if the upstarts fail to break the grip of the telecom giants, Wall Street analysts speculate, the upstarts will possess tremendously valuable capacity and will likely become ripe takeover targets. Either way, they figure, investors win.

The Yankee Group's Peterson, however, is not entirely convinced. "All of this is highly speculative. It's a complex industry. ... There's no easy answer for investors," he said. "In the end, you are going to be judged on the ability to grow revenue streams."

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